Modi’s Revolutionary Tax Overhaul

May 8, 2015 4 minute read

Modi’s Revolutionary Tax Overhaul

Modi’s Revolutionary Tax Overhaul

Dubbed as the biggest tax change since Indian independence, the GST (Goods and Services Tax) aims to simplify one of the world’s most complex tax regimes. When an item moves across India it is taxed multiple times (taxation rates differ per state, further complicating matters) as it crosses state boundaries by local bodies. This causes confusion, delays and aids corruption. Even firms who are willing to pay taxes are dissuaded from paying them for having to deal with a plethora of government officials whose aim is sometimes to extract bribes. The GST aims to replace such local taxes with a single federal tax in order to create a single market. The states and local bodies will be compensated for their revenue loss via federal funds.

The government of India hopes that this tax will raise overall revenue as tax evasion becomes harder and efficiency increases. India has one of the lowest tax to GDP ratios in the world and a boost in net revenue will allow the government to cut the budget deficit and also boost social spending simultaneously. It will also be hoped that manufacturing can be spurred on in all parts of India under the “Make in India” campaign and bridge the gap between “producing” and “consuming” states.

The GST (also known as VAT in some countries) has been implemented across the world. In commonwealth countries such as Canada and New Zealand it has raised net revenue collected and generally been a progressive tax. So there is precedent for implementation. But both these countries are developed, not rampant with corruption. Malaysia, another developing country in the neighbourhood has recently implemented the tax. India should be keeping an eye on how things pan out learning from its mistakes and outcomes.

There are however some downsides. Firstly, whilst transparency and simplicity are significant positives, the Finance Minister, Arun Jaitley’s comment of the GST boosting GDP growth by 1-2% will be flawed, if the net tax burden increases over time. The federal government may see it as a quick fix to boost revenue, making India a somewhat uncompetitive country for business. Competent state governments can be penalised as a result. It also assumes that the central government is less corrupt than local governments. Whilst Prime Minister Modi has a clean image, there is no guarantee this will always be the case with future governments. To combat these problems, there needs to perhaps be a law to check the federal government’s ability to raise GST rates to ward off populist tendencies. The current law does make provisions for the states to block any unanimous moves, however considering the party governing the centre usually has power in multiple states the Finance Minister effectively has the ultimate authority.

The dogmatic aim of the government to fully implement the GST by 1st April 2016 is also worrying. There is a good chance the bill will not become a law by this date. India in the past has levied retrospective taxes on the likes of Vodafone. What foreign companies fear the most is a lack of clarity. Should this bill actually become law in 2017 or 2018, many foreign firms could find themselves in a tax nightmare of having to pay a tax bill from 2016. As a result, many are treading cautiously with investment and expansion plans within the country, crimping growth. The government need to make their stance clear, putting an end to the rumours and speculation.

Politically, the government will need to rely on the goodwill of a partisan opposition to pass the bill. Such a constitutional amendment will need two-thirds majority in the upper and lower houses of parliament. In addition the bill has to be passed by half of the state legislatures. Currently the bill has passed the lower house where the government holds a majority. The real test will come in the upper house, where it lacks numbers. The bill has already been delayed by 10 years. Should the Modi government manage to overcome the aforementioned obstacles, it will be a shining example of what sets India apart from other emerging markets, a reform minded government.

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